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The Arduino's RESET pin has a pullup resistor in it (10KΩ). That keeps the RESET pin normally HIGH. To invoke a reset that pin needs pulling low, and that is done from a number of sources:

The RESET button

The DTR pin (through a 100nF capacitor) of the USB interface chip

The 555 watchdog circuit above

The critical one there is the DTR pin. That, because it's a brief pulse with quite a high output impedance, needs the reset pin to be easy to pull down. If you connected the output of the 555 directly to RESET it would be constantly trying to pull the RESET pin up to 5V with quite a low output impedance. The DTR circuit would have no chance of overcoming it.

So by adding a diode in there you get Wired Or, using an arrangement direct from the 1950s - DRL - Diode-Resistor Logic. When the output of the 555 is HIGH the diode is reverse biased (or neutrally biased) and doesn't conduct, so the RESET pin's own resistor pulls the RESET pin up. However, when the output of the 555 is LOW the diode can then conduct (it's forward biased) and that pulls the RESET pin LOW.

Thanks for the information @Majenko. It was really helpful. I have a small confusion. The RESET pin is not a source of voltage or current, right? So how does the RESET pin become LOW as soon as the 555 is low with the diode conducting? I mean how does current flow from the RESET pin if its not a source of current?
– bukke hari prasadFeb 7 '18 at 14:47

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Yes, it is a source of voltage and current. It is connected to +5V through a 10K resistor. Connect it to ground and (5/10,000) 5uA will flow from it to ground.
– Majenko♦Feb 7 '18 at 14:50

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Every pin is either a source or sink (or both) of current. It's all a matter of how much current (the output impedance) the pin can sink or source.
– Majenko♦Feb 7 '18 at 14:51